International credit rating agency Moody’s announced on Tuesday that the outlook for Egypt’s banking system remains Negative, reflecting the continuing political and social tensions as well as the “government’s strained finances”.

“Against the backdrop of the unsettled security situation and political climate, the banks’ operating environment will remain difficult,” said Constantinos Kypreos, Senior Credit Officer at Moody’s Investors Service. “This is because the outlook for foreign investment, tourism and consumer confidence remains weak, leading to subdued credit growth and low business generation for banks.”

Moody’s said that the banks’ exposure to the Caa1 rated government debt poses a credit risk and ties their ability to meet long-term financial obligations to sovereign default risk.

“Banks’ thin capital buffers are also insufficient to absorb potential losses under Moody’s scenario analysis,” the international agency added.

The report, titled “Banking System Outlook”, indicated that banks would not face funding shortages due to their strong deposit bases. According to Moody’s, customer deposits comprise over 76% of the banking assets as of September 2013.

The rating agency added that the pool of deposits in the bank allows them to operate with minimum reliance on foreign funding and riskier markets. The report said that banks will face some challenges regarding liquidity and profitability, however.

“Banks face a liquidity squeeze in foreign currency, as the government maintains currency and exchange controls,” Moody’s said.

The report added that the banks’ profitability is under increasing pressure, a result of “rising loan-loss provisioning charges, lower interest rates and declining government bond yields.”Providing forecasts for the banking system, Moody’s pointed out that over the next 12-18 months, banks’ exposure to government securities will rise.

“The government continues to rely on local banks to fill the funding gap in the absence of foreign funding and continues to run high budget deficits,” the international rating agency noted, adding that “the high exposure to sovereign paper is the major credit risk for linking the banking system’s credit profile directly to that of the Egyptian sovereign.”

Moody’s report noted that government’s ability to support the banking system has significantly diminished.

The agency also forecasted that Egypt’s gross domestic product (GDP) would reach around 2.9% in 2014.

Moody’s stated that the Egyptian economy could regain strength over the medium-term because it is “relatively large and diversified”.

Earlier in October, the international agency announced that it is maintaining its negative outlook and Caa1 sovereign rating on Egypt due to ongoing economic and political uncertainty since the 25 January Revolution.

“Political uncertainty and turmoil in Egypt since the eruption of the revolution in January 2011 remain a constraint on the country’s credit profile,” Moody’s said, adding that the “Fiscal deficits have widened sharply as heightened social tensions led to higher wage and subsidy expenditures, while weak economic conditions have also depressed [Egypt’s] revenue performance.”